Question

Assume the market for soybeans is a perfectly competitive market. Now suppose the cost of renting farmland increases (i.e. fixed resource costs have gone up). As a reference for your answer, graph this increase to average costs. (Important: since this is a fixed cost, we're assuming marginal costs do not shift, only average costs.)

1. What will happen to the number of producers? Why is this the case?
2. What will happen to the supply curve and the market price? Show this in a market-level graph.
3. Suppose the market for soybeans was instead a pure monopoly. What does our model suggest will happen to production quantities and market prices if we have the same increase to average costs described above? Show this in a graph as well.

Answer 1

Let the soybean market was at long run equilibrium. that is P=ATC=MC with market price equal to P0. The increase in the rent of the farmland increases the average total cost of the firm. This shifted the average total cost curve upward. This increases the average total cost over the current market price P0. That is P0<ATC. At the current market price the firm now earn negative profit. This prompted many farm to to exit the industry. As firm exit industry the market supply curve falls from S0 to S1. Given the market demand curve D, this increases the price of soybeans. The price continue to rise as long as price is less than new minimum average total cost and each farm earn negative economic profit. That is price increases to P1=ATC1=MC1. This is shown in the figure above. Therefore the increase in average total cost, decreases the number of firms in the market and increases the price in the long run.

In case of monopoly, the equilibrium is at MR=MC. With demand and the marginal cost constant, the rise in ATC does not alter equilibrium quantity or the market price. The only change that affects the monopolistic is the difference between price and average total cost. As ATC rises, given the P, the profit of the monopolist shrinks. This is given in the figure as area A+B decreases to area A only.